Portfolio Valuation Services

The Paramount Deal: A Reality Check on ValuationsOn September 17, 2025, alternative asset manager Rith Capital Corp. (NYSE:RITM) agreed to acquire office REIT Paramount Group, Inc. (NYSE:PGRE) for $1.5 billion cash, or $6.60 per share. Paramount is an integrated REIT that manages and owns 13.1 million square feet of Class A offices (86% occupancy rate) in New York and San Francisco.Word of the deal, but not the price, leaked because the shares rose 4% on September 16 to $7.39 per share on volume that was 5x above average. Relative to the pre-leak closing price on September 15, the deal price represented a 7% discount and equated to 48% of book value and 10.2x funds from operations (“FFO”).By way of comparison, RITM’s shares as of year-end 2019 closed at $13.92 per share, which equated to 82% of book value and 14.5x LTM FFO. And for those who can time the market, the shares traded just below $4.00 per share immediately after “Liberation Day” and thereby provided a great five-month return.When Book Value Isn’t Market ValueParamount was not a high-flyer. The dividend was suspended in September 2024 after having been cut in June 2023 and December 2020. The stock traded below book value for years. The public market and change-of-control transactions imply the carrying value of the assets was too high though the 2024 10-K notes that real estate assets carried at cost less accumulated depreciation are individually reviewed for any impairment.Aside from an impairment issue, GAAP did not dictate that the $8.3 billion land, buildings and improvements be marked-to-market so that book value could be directly equated with net asset value (“NAV”). Nonetheless, investors did so daily yet still over-estimated NAV that a competitive process revealed it to be in a change-of-control transaction.Secondary Pricing as % of NAV (by weighted average volume)The Broader Challenge: Overstated NAVs in Private MarketsParamount illustrates what some think is a pervasive issue in private equity and to a lesser extent private credit whereby fair value marks and therefore NAVs are too high. An unwillingness to recognize reality may be one reason PE exits are too low relative to investment. Assets are held in the hope that next year conditions will be better – the M&A market improves, the company’s earnings will be higher, etc.Continuation Funds and Valuation GapsContinuation vehicles (“CV”) with five year lives that acquire assets from PE funds are a bridge to a potentially better tomorrow, but valuation gaps today based upon what the CV asset marketing process reveals vis-И-vis the current mark can be material though the data is nuanced. Evercore in its mid-year 2025 update estimates that 87% of GP-led secondaries transacted at less than NAV. Lazard estimates that 90% of single-asset and 70% of multi-asset GP-led secondaries transacted at 90% of NAV or higher in 2024. However, the data does not distinguish between cash paid at closing and contingent earn-out payments; so, the effective transaction price vs NAV may be wider. LP-led secondaries offer additional perspective—albeit for a portfolio interest vs one or more ~plum assets—with discounts to NAV on the order of 10% for buyout interests vs 25% for venture and real estate assets. One could argue the LP discount or some portion of it reflects an illiquidity discount vs appropriateness of the NAV mark forthe portfolio.Governance Under Pressure: The Business Judgment RuleDirectors of corporations operate under the long-held concept of the Business Judgment Rule (“BJR”) where courts generally will not second guess decisions as long as directors do not violate the fiduciary triad of care (informed decision making), loyalty (interests aligned with shareholders, conflicts fully disclosed), and good faith. Application of the BJR to GPs varies by state and will be viewed through the lens of the partnership agreement when disputes arise.BJR murkiness notwithstanding, GP-led secondary transactions are problematic from a governance perspective because GPs are both seller and buyer, and the GP has a financial incentive to extend the period on which management fees and carry are earned. Secondary Market Transaction Volume Over Time ($bn)The Role of Fairness OpinionsThe institutionalization of GP-led continuation funds has led to the development of a fair dealing process to address the loyalty question—at least outwardly—in which a third-party financial advisor markets the subject asset(s) to investors who would capitalize a CV. The proposal with the combination of the best price and terms with confirmed access to capital will be selected to transact subject to a conflict of interest waiver from the LP advisory committee (“LPAC”).Third-party fairness opinions emerge as indispensable here for the LPAC, bridging process and price vis-И-vis the historical fair value marks. Unlike binary “fair/unfair” verdicts, these assessments—rooted in rigorous due diligence—evaluate the marketing process, transaction terms from a financial point of view, dissecting NAV assumptions, cap rates, and exit multiples against market comps.Best Practices and Industry GuidanceFor continuation funds, the stakes are higher: GPs must demonstrate that discounts reflect arm’s-length negotiations, not convenient happenstance. The CFA Institute research on ethics in private markets emphasizes competitive bidding processes to mitigate manager incentives—strong financial additions like promoted interests in the new fund can skew outcomes toward overvaluation. ILPA’s 2023 guidance amplifies this, urging 30-45 day timelines for LP re-underwriting, full disclosures on advisor conflicts, and LPAC pre-approvals to safeguard alignment.Beyond a Checkbox: Upholding Fiduciary IntegrityUltimately, fairness opinions are not mere check boxes; they are part of the governance protocol to address the care and loyalty duties that are the cornerstone of the BJR.About Mercer CapitalMercer Capital is an independent valuation and financial advisory firm founded in 1982, specializing in business valuation, corporate transactions, and financial opinions. With offices in Dallas, Houston, Memphis, Nashville, and Winter Park, we serve private equity sponsors, portfolio companies, and institutional investors in valuing complex, illiquid equity, credit, mezzanine and other such securities. Our fairness opinion practice, a cornerstone of our expertise, provides objective assessments for conflicted transactions such as GP-led secondaries and continuation funds. Drawing on deep market insights and rigorous due diligence, we help clients navigate governance challenges, ensure regulatory compliance, and maximize stakeholder alignment. For more, visit mercercapital.com.Originally featured in Mercer Capital's Portfolio Valuation Newsletter: Fall 2025

In recent years, financial sponsors such as private equity, venture capital firms, investment companies, and family offices have taken a more prominent role in funding and growing firms in the insurance industry. From insurance brokerage/distribution to underwriting to InsurTech start-ups, there are many opportunities for investment in the insurance sector and transaction activity in the space has steadily been increasing.Mercer Capital has worked with financial sponsors in the insurance industry for years and we understand both the dynamics of the industry as well as the accounting and valuation issues that are likely to be encountered.Key areas where Mercer Capital can help include:Valuations of Shares/Units for 409A / ASC 718 Compliance – If you anticipate granting equity to founders or key management at acquired companies, using rollover equity as part of a growth strategy, or issuing options or RSUs as part of your employee compensation plans, supportable and defensible valuations are critically important.Valuations for Financial Reporting – Acquisitive growth strategies will likely necessitate ASC 805 purchase price allocations, earn-out liability measurements, and goodwill impairment testing.Financial Due Diligence – We provide financial due diligence and quality of earnings reports on target companies, including analysis/trending of the pro forma P&L, potential earnings adjustments, working capital assessments, unit economics analysis, and other areas of financial analysis.Financial Opinions (Fairness and Solvency Opinions) – Certain types of transactions, related-party issues, or fiduciary concerns can lead a board to seek an independent opinion of fairness or solvency as it pertains to a transaction involving the subject company. These situations might include going-private transactions, special dividends, and leveraged recapitalizations.Portfolio Valuation for ASC 820 Compliance – We provide a range of services to assist fund managers with the preparation and/or review of periodic fair value marks. These services are cost-effective and include a series of established procedures designed to provide both internal and investor confidence in the fair value determinations.To discuss any of these services in confidence, please contact a Mercer Capital professional today.

Rising regulatory burdens contributed to the stunning growth in private equity the last two decades and private credit in recent years. PE investors ultimately require liquidity, however.Subdued M&A and IPO markets since mid-2022 have spurred growth for private equity secondaries, which mostly consists of GP-initiated transactions for continuation funds and LP-initiated transactions for portfolio interests.As shown in Figure 1, secondary transactions rose to $109 billion in 2023 from $102 billion in 2022 based upon data compiled by Lazard as volume soared 57% in 2H23 to $67 billion following depressed activity of about $43 billion in 2H22 and 1H23. Lazard expects secondary volume will improve further in 2024 and 2025 as the investor base for secondaries expands and buoyant markets support narrower bid-ask spreads. The need for LP liquidity also has driven the rise of NAV lending in which the GP arranges for a fund-level loan to fund distributions and/or acquisitions.Figure 1Lazard reports that LP secondaries of buyout funds realized ~88% of NAV whereas LPs realized only ~60% of NAV for interests in funds focused on early stage venture capital assuming NAV was not materially overestimated. LPs averaged 85% for interest in private credit funds, which is less than we would have guessed.LP investors can decide whether it makes sense to transact at a price that is less than NAV and thereby convey to the buyer additional return from investing in an illiquid asset. The LP investor will weigh the cost against the expected return from the current investment, the need for liquidity, and the opportunity to deploy the returned capital in new ventures.GP-led transactions for continuation funds create a corporate governance can of worms because the GP sits on both sides of the transaction as adviser to the fund that is selling an asset and as adviser to the fund that will buy it. LPs can choose liquidity on the terms offered, or they can roll their interest into the continuation fund. Whether a single asset or multi asset investment, presumably the GP is using a continuation vehicle because the exit price for an attractive asset is presently unattractive.The SEC addressed the issue through adopting Rule 211(h)(2)-2 in August 2023 which requires the GP adviser to: (a) obtain a fairness opinion or valuation from an independent valuation firm; and (b) disclose any material business relationships between the GP and opinion provider. Given the increase in GP-led secondaries to $31 billion in 2H23 from $17 billion in 1H23, the SEC governance requirement has not slowed the market.Although not mandated by law, fairness opinions for significant corporate transactions effectively have been required since 1985 when the Delaware Supreme Court ruled in Smith v. Van Gorkom, (Trans Union), (488 A. 2d Del. 1985) that directors were grossly negligent for approving a merger without sufficient inquiry. The Court suggested directors could have addressed their duty of care (informed decision making) by obtaining a fairness opinion.The SEC rule takes aim at the corporate duty of loyalty, which with the duty of care and good faith form the triad that underpins the Business Judgement Rule in which courts defer to the decision making of directors provided they have not violated one of their duties. As far as we know, there has been no widespread finger pointing that GP-led transactions have intentionally disadvantaged LPs. Nonetheless, the SEC rule is a regulatory means to address the issue of loyalty.Fairness opinions involve a review of a transaction from a financial point of view that considers value (as a range concept) and the process the board followed. Due diligence work is crucial to the development of the opinion because there is no bright line test that consideration to be received or paid is fair or not.Mercer Capital has over four decades of experience as an independent valuation and financial advisory firm in valuing illiquid equity and credit, assessing transactions and issuing fairness opinions. Please call if we can be of assistance in valuing your funds private equity and credit investments or evaluating a proposed GP-led transaction.Originally featured in Mercer Capital's Portfolio Valuation Newsletter: Summer 2025

FEATURE ARTICLESolvency of the SponsorAlso in This IssueUpdated Metrics forPrivate Credit and EquityPublicly Traded Private CreditVenture Capital

A Look at WeWork’s Failed IPOIn last quarter’s issue of Portfolio Valuation we raised the issue as to whether public market investors are more critical (or discerning) in establishing value than private equity investors.The evidence this year largely is, yes—at least for companies where there is skepticism as to whether meaningful profitability can be achieved. Lyft, SmileDirectClub and Uber are examples of unicorns that saw share prices marked sharply lower after the IPO (Lyft, SDC) or during the roadshow (Uber); and The We Company’s planned IPO never occurred due to pushback by investors. At the other extreme is Beyond Meat, which as of early October had risen about six-fold from its May IPO.The We Company’s (formerly “WeWork” and will be refered to in this article as WeWork) valuation journey is interesting (maybe even fascinating).WeWork, which was founded in 2010, is a real estate company that signs long-term leases for pricey real estate that it refurbishes then releases the space short-term. The company describes itself somewhat differently as a “community company committed to maximum global impact.” The S-1 disclosed not only massive losses, but also significant corporate governance issues.Year-to-date revenues through June 30, 2019 doubled to $1.5 billion from the comparable period in 2018, but the operating loss also doubled to $1.4 billion.EBITDA for the six months was negative $511 million, while capex totaled $1.3 billion. That is a big hole to fill every six months before factoring in rapid growth to be financed.Cash as of June 30 totaled $2.5 billion, while the capital structure entails a lot of debt and negative equity. From a valuation perspective, WeWork is problematic because operating cash flows are deep in the red with little prospect of turning positive anytime soon. Nonetheless, the increase in value private equity investors placed on the company was astounding. The company pierced the unicorn threshold in early 2014 when affiliates of JPMorgan invested $150 million in the fourth funding at a post-raise $1.5 billion valuation. T. Rowe Price and Goldman Sachs invested $434 million in late 2014, which resulted in a post raise valuation of $10 billion. The 7th and 8th funding rounds are where the valuation really gets interesting.In August 2017 SoftBank Vision Fund invested $3.1 billion, which implied a valuation of $21 billion.SoftBank Group Corp., which sponsors the Vision Fund, invested $4.0 billion in January 2019 at an implied valuation of $47 billion. When the underwriters were forced to pull the plug on the IPO the targeted post-raise valuation reportedly was $10 billion to $15 billion—a value the company apparently was willing to accept because it needs the cash.We do not know exactly how private equity investors valued the company.Presumably discounted cash flow (DCF), guideline public company and guideline transaction methods were used, perhaps overlaid with a Monte Carlo simulation.The valuation history raises an important question: how was a stupendous valuation achieved in the private markets by a cash incinerator such as WeWork? A similar question could be asked about many high-profile PE-backed investments.The short answer is that Softbank thinks the valuation increased significantly even though the company’s fundamentals argue otherwise. Prospective investors such as the public ones who were offered WeWork shares in an IPO could prepare their own DCF forecast to value the company.They also could examine past transactions in the company for relevant valuation information. Likewise, they could examine capital transactions in similar companies.Both sets of data fall under the guideline transaction method. A transaction in a privately held company infers a meaningful data point about value to investors, but there are a couple of caveats.One is an assumption that both parties are fully-informed and neither is forced to transact.Great values were realized by those willing to buy during the 2008 meltdown because there were so many forced sellers that ran the gamut from levered credit investors forced to dump bonds to the likes of Wachovia Corporation and National City Corporation. The price data was legitimate, but many sellers faced margin calls and had to dump assets into an illiquid market.Is the valuation data relevant if “normal” market conditions prevail?The second issue relates to private equity valuation generally, but especially those where start-up losses and ongoing capital requirements can be huge.The valuation issue relates to using transaction data from investments in other money losing enterprises.Is it always valid to apply multiples paid by investors in a funding round of a money-losing business to value another money-losing business? The valuation data may be factual, but it may be nonsense when weighed against the business’ operating and financial performance.One can question Softbank’s motives.Did Softbank need a higher valuation to offset losses in other parts of the portfolio in order to maintain investor and lender confidence? Was a higher valuation necessary to support upcoming capital raises? We do not know, but prospective public investors were dismissive of Softbank’s valuations and they appear to be dismissive of the prior two raises given how low the price talk had fallen by the time the IPO was pulled. We at Mercer Capital respect markets and the pricing information that is conveyed.The prices at which assets transact in private and public markets are critical observations; however, so too are a subject company’s underlying fundamentals, especially the ability to produce positive operating cash flow and a return on capital that at least approximates the cost of capital provided.Mercer Capital can assist with the valuation of your portfolio companies.We value hundreds of debt and equity securities of privately held companies every year and have been doing so for nearly four decades.Please call if we can assist in the valuation of your portfolio companies.Originally published in Mercer Capital’s Portfolio Valuation Newsletter:Third Quarter 2019

The IPO market is hot thanks to the intersection of investor enthusiasm and a new crop of venture capital-backed, and in some instances traditional private equity-backed, firms that have gone public. Unicorns (pre-IPO valuation of $1 billion or more) in particular have caught investors’ attention. There is nothing new about a hot IPO cycle in the U.S. IPO activity waxes and wanes with markets. The last massive wave occurred in 1999 when a mania swept through markets as then internet and other technology-focused companies captured investors’ imaginations.1999 vs. 2019Why has 2019 become the year of the unicorn IPO? It could be a matter of timing and monetary policy. After a nearly ten-year bull market, private equity is monetizing while the IPO window remains open after it more or less closed in the fourth quarter of 2018. Also, easy money policies the past decade arguably have incented investors to shower capital on growth-focused tech companies. With the Fed likely to begin cutting rates again in 2019, capital flows may intensify again.Nonetheless, the current IPO wave is different from 1999 and other peaks on three related counts. One is the length of time most venture-backed companies have remained private before going public. The other is the staggering amount of losses incurred even on an “adjusted” basis before going public. The link between the two differences has been the willingness of deep-pocketed investors, such as SoftBank, to fund losses through multiple capital raises. The link gives rise to the third difference: staggeringly large private market valuations for some.Looking at how several of the big name public offerings have fared this year, we can’t help but wonder:Do current losses matter to public market investors?Did the private market overvalue these unicorns?What does all of this mean for other unicorns planning to go public in 2019?The short answers are: perhaps, probably, and hurry.Sentiment Toward Recent UnicornsPublic investors seemingly have been more discerning about losses than private investors who pushed valuations higher for many companies with successive funding rounds. Price performance in the post-IPO market has been uneven as would be expected, but it points to less tolerance among public market investors to the extent big money losers such as Lyft and Uber have much lower valuations today than expected when their IPO roadshows were launched. Blue Apron is a poster child for a disaster post-IPO stock, but it is not alone.Lyft and Uber point to the more critical view public investors have taken of each company’s business model as it relates to future earnings. Lyft priced near the high end of the range targeted initially by lead underwriter JPMorgan and then saw strong first day performance; however, it now trades about 15% below the IPO price.Uber has traded down modestly from the IPO price, but lead underwriter Morgan Stanley had to sharply reduce the IPO price from when the roadshow started with price talk of a $90 billion to $100 billion post-raise valuation compared to about $73 billion presently.Uber and Lyft posted the highest revenue growth over the prior three years, but also the largest losses. The losses didn’t prohibit the companies from going public, but the uncertainty of a future path to profitability has led to disappointing performance relative to the hype that has surrounded the companies. Perhaps investors see a better outlook for Slack Technologies, which went public via a direct listing on the NYSE in mid-June. Although the company is not yet profitable, the shares rose nearly 50% on the first day of trading as either investors see a path to profitability or too few shares were floated. On the other hand, both Tradeweb and Zoom among a number of newly minted tech companies have performed well since their respective IPOs. Both were profitable in the year prior to the IPO, which is more in line with the kind of pre-offering financials that public investors are used to seeing. The market has rewarded the two companies accordingly. The next big name to test investors’ willingness to fund sizable losses is The We Company. The company confidentially filed for an IPO at the end of 2018 and is expected to begin a roadshow soon. The We Company may be the ultimate unicorn to test the market. It is minting losses. Only through the company’s defined term “community adjusted” EBITDA, which is akin to a twice-adjusted EBITDA, does the company post positive EBITDA. Also, the company has a huge $45 billion valuation based upon its last fundraising round; yet, its business model may be suspect in that it entails acquiring expensive real estate that generally is leased under short-term arrangements. Presumably, in a recession, lease rates would plummet as vacancies soar.Some have raised legitimate questions about valuation processes employed by private equity and VC firms and whether private market valuations are too high. Others have noted investors can, in effect, mark-up the value of prior investments by investing in follow-on capital raises for a given company at a higher valuation. ConclusionWe do not mean to disparage anyone with the issues raised in this article. We respect markets and the pricing information that is conveyed. The prices at which assets transact in private and public markets are critical observations; however, so too are a subject company’s underlying fundamentals, especially the ability to produce positive operating cash flow and a return on capital that at least approximates the cost of capital provided.At Mercer Capital we have been valuing private equity and private credit securities for nearly four decades and have deep experience in most industries. If we can help you establish the value of securities held in your fund or offer a second opinion, please call. We would be glad to assist. Stock Performance Since IPO (Pricing as of 6/20/19)Three Year Financial PerformancePrivate vs. Public Valuation (Pricing as of 6/20/19)Originally published in Mercer Capital’s Portfolio Valuation Newsletter: Second Quarter 2019

The extensive use of core versus reported earnings by public companies has been a widespread phenomenon for at least 25 years. During the past decade, the practice also has become widespread among companies (and their bankers who market deals) that are issuing debt in the leverage loan and high yield markets.The practice is controversial. The SEC periodically will crack down on companies it thinks are pushing the envelope. Bank regulators have raised the issue of questionable adjustments to borrowers’ EBITDA for widely syndicated leverage loans.Investors are aware of the issue, too, but have not demanded the practice to stop. In mid-2017, I attended a conference on private credit. One session dealt exclusively with adjusted EBITDA. One panelist offered that adjustments in the range of 5-10% of reported EBITDA were okay, but the consensus was the adjustments were out of control. Covenant Review reported that as of mid-2017 the average leverage for middle market LBOs over the prior two years was 5.5x based upon the target’s adjusted EBITDA compared to reported EBITDA of ~7x. The issue is no better, and perhaps worse, in 2018 judging from market sentiment.If investors are solely relying upon company defined adjusted EBITDA, then they may be vacating their fiduciary duties when investing capital. That said, an analysis of core versus reported earnings is a critical element of any valuation or credit assessment of a non-early stage company with an established financial history.Table 1 below provides a sample overview of the template we use at Mercer Capital. The process is not intended to create an alternate reality; rather, it is designed to shed light on core trends about where the company has been and where it may be headed.AdjustmentsAdjustments typically consist of items that are non-recurring, unusual, and infrequent. They also may entail elements for a change in business operations, such as the addition of a new product or the discontinuation of a division. This is where judgment is particularly important because we have noticed a trend among some investors to credit businesses with future earnings for initiatives such as stepped-up hiring of revenue producers in which a favorable outcome is highly uncertain.Minority vs. ControlAdjustments considered should take into account whether the valuation is on a minority interest or controlling interest basis. An adjustment for an unusual litigation expense will not be impacted by the level-of-value; however, other potential adjustments—particularly synergies a buyer could reasonably be expected to realize would only apply in a control valuation.Core Trends vs. PeersThe development of the adjusted earnings analysis should allow one to identify the source of revenue growth and the trend in margins through a business cycle. The process also will facilitate comparisons with peers both historically and currently to thereby make further qualitative judgments about how the business is performing.Out Year Budget vs. Adjusted HistoryThe adjusted earnings history should create a bridge to next year’s budget, and the budget a bridge to multi-year projections. The basic question should be addressed: Does the historical trend in adjusted earnings lead one to conclude that the budget and multi-year projections are reasonable with the underlying premise that the adjustments applied are reasonable?Core Earnings vs. Ongoing Earning PowerCore earnings differ from earning power. Core earnings represent earnings after adjustments are made for non-recurring items and the like in a particular year. Earning power represents a base earning measure that is representative through the firm’s (or industry’s) business cycle and, therefore, requires examination of adjusted earnings ideally over an entire business cycle. If the company has grown such that adjusted earnings several years ago are less relevant, then earning power can be derived from the product of a representative revenue measure such as the latest 12 months or even the budget and an average EBITDA margin over the business cycle.Platform Companies/Roll-UpsCompanies that are executing a roll-up strategy can be particularly nettlesome from a valuation perspective because there typically is a string of acquisitions that require multiple adjustments for transaction related expenses and the expected earnings contribution of the targets. The math of adding and subtracting is straightforward, but what is usually lacking is seasoning in which a several year period without acquisitions can be observed in order to discern if past acquisitions have been accretive to earnings. Public market investors struggle with this phenomenon, too, but often the high growth profile of roll-ups will trump questions about earning power and what is an appropriate multiple until growth slows.Income and Market-Based Valuation ApproachesIn addition to providing insight into how a business is performing, the adjusted earnings statement will “feed” multiple valuation methods. These include the Discounted Cash Flow and Single Period Earning Power Capitalization Methods that fall under the Income Approach, and the Guideline (Public) Company and Guideline (M&A) Transaction Methods that constitute Market Approaches.It may be obvious, but we believe an analysis of adjusted (and reported) earnings statements for a subject company over a multi-year period is a critical, if not the critical element, in valuing securities that are held in private equity and credit portfolios. Mercer Capital has nearly 40 years of experience in which tens of thousands of adjusted earnings statements have been created. Please call if we can help you value investments held in your portfolio.Originally published in Mercer Capital’s Portfolio Valuation Newsletter: Fourth Quarter 2018

Many family offices are built from the success of once fledgling businesses that many would now know as household names. Successor generations seek to maintain and build that wealth through prudent investments in equities, fixed income, and private equity investments in mature companies. In recent years, however, family offices have started taking notes from their entrepreneurial beginnings and are investing more in early-stage ventures. Though more often seen as LPs in traditional venture capital funds, family offices are also increasingly taking on the role of direct—and sometimes lead—venture investors.An analysis from Crunchbase News shows the progression of family office venture investment over the last few years. While this is a small sample, it helps demonstrate the growing trend. Crunchbase also notes several prominent family venture-backed exits including Twilio, Okta, Bitly, and Workday.We have previously analyzed the rise of corporate venture capital and its effect on the funding landscape. So what does the increase in family office investors mean for venture capital? Here are a few of the characteristics that make venture investments from family offices unique.InvolvementDespite an industry focus on the new wealth being built in the technology hubs of the U.S., abundant sources of potential investment lay in family offices all over the country. Family office investors are likely to source deals through their personal networks and professional ties with local business activity. Family offices typically take an active interest in each portfolio company and, therefore, may be likely to invest their capital in local ventures in order to better stay up-to-date with company developments. In order to maintain this involvement, a board seat may also be one of the requirements when a family office joins the cap table.MotivationWhether they hold a share of the original family company or a subsequent business investment, family offices often have a stake in mature industry players. Because of previous work within the space or an inside vantage point from an ownership position, family offices can often lend industry insight. They may also possess a unique perspective for identifying startups that could disrupt, or partner with, the incumbents in the industry. Family office investors typically enter with strategic motivations for investing, not just the lure of large returns.Time HorizonThe primary focus of family offices is to preserve and grow capital for multiple generations. Family offices are, therefore, usually able to adopt a very long-term view of their overall portfolio. However, it should not be mistaken that family offices are willing to have their capital tied up forever. Like any other investment firm, family offices develop objectives and exit expectations for their various investments.As family offices join the landscape of non-traditional investors in venture capital, startups may find that they have more options when it comes to funding. We expect to continue to see an increase in the diversity of funding sources, with cap tables boasting a combination of traditional, corporate, and family investors.Originally published in Portfolio Valuation: Private Equity & Venture Capital Marks & Trends, Third Quarter 2018.

Corporate venture capital has increased as an investment activity for large corporations in recent years. By one count, the top ten corporate venture capital groups made 1,640 investments between 2010 and 2016.Intel Capital, the most active corporate venture capital investor over the past six years, made investments in 34 new companies totaling $455 million in 2016 alone.With corporate venture capital activity on the rise, a keen eye is being turned to public company reporting of equity holdings, as well. Valuations of VC-backed startups have grown rapidly in recent years, making many early venture investments worth well in excess of original cost. For example, Google Ventures (GV) invested in AirBnB in late 2010 at a valuation of $71.8 million. In March 2017, less than seven years later, AirBnB completed a $448 million financing round at a reported valuation of $29.3 billion, an increase in post-money value of more than 400x since the 2010 investment. [Source: VC Experts]Yet, many corporate balance sheets carry minority investments at cost – the value originally paid for the interest. Current U.S. GAAP does not require disclosure of the gains (and occasional losses) attributable to minority investments held at cost. While the incumbent accounting methodologies provide some information about deterioration in investment value, large valuation increases remain largely hidden from view. Unlike an asset for which replacement cost similar to the original outlay may be a reasonable estimate of worth, the value of investments in fledgling investee startups can change dramatically as these companies develop into successful businesses. With startups remaining private longer in the absence of exit events like IPOs, rising valuations of the underlying companies can diverge significantly from the cost basis of early investments. ASU 2016-01 seeks to provide more transparency and relevance to financial statement users, as well as decrease the complexity of equity investment impairment testing for financial statement preparers. The guidance applies to all equity investments that are not consolidated with the investor or accounted for under the equity method.1 That is, investments that represent less than 20% ownership or for which the owner lacks influence over investee operations. While the update has applications to both financial assets and financial liabilities, in this whitepaper we focus on the former, specifically minority equity interests. The update divides these investments into securities with readily determinable fair values and those without readily determinable fair values.Under current GAAP, unconsolidated equity investments are accounted for using either the cost or equity method. Investments with a readily determinable fair value (such as a share of public company stock) will be carried at fair value. For equity investments without a readily determinable fair value, entities can choose to apply a new Measurement Alternative. “An entity may elect to measure an equity security without a readily determinable fair value [and that does not qualify for the ASC 820 practical expedient2] at its cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer.”3 Elections to measure a security using this guidance may be made on an investment-by-investment basis. However, once an entity elects to measure an equity security using the Measurement Alternatively, it should be applied consistently unless the alternative is no longer permitted.Observable price changes mean those resulting from orderly transactions, including those that are known or can reasonably be known at the date of measurement. However, it is important to note that the transactions must involve identical or similar investments from the same issuer. Determining the similarity of a new security issuance to one held by the reporting company should take into consideration the specific rights and obligations of the issuance, such as voting rights, distribution rights and preferences, and conversion features. While simplifying the process of determining changes (both upward and downward) to the reported value of equity investments, the Measurement Alternative does not eliminate the need to test for impairment. However, it does allow for the use of a single-step qualitative assessment at each reporting period. Qualitative indications of impairment include, but are not limited to, the following.4 A significant deterioration in the earnings performance, credit rating, asset quality, or business prospects of the investee.A significant adverse change in the regulatory, economic, or technological environment of the investee.A significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates.A bona fide offer to purchase, an offer by the investee to sell, or a completed auction process for the same or similar investment for an amount less than the carrying amount of that investment.Factors that raise significant concerns about the investee’s ability to continue as a going concern, such as negative cash flows from operations, working capital deficiencies, or noncompliance with statutory capital requirements or debt covenants.If a qualitative impairment is identified, the reporting entity should estimate the fair value of the investment and recognize an impairment loss equal to the difference between the carrying amount of the investment and its fair value. Although the intended result of ASU 2016-01 is to increase the scope of decision-useful information reported on corporate balance sheets, it also has the potential to complicate reporting for entities with investments in venture-backed startups. Re-measuring fair value of ownership interests in companies that have become significantly more valuable since the reporting entity’s initial investment could result in higher volatility of reported income (from non-core business sources). Beginning in their quarterly 2017 filings, a few major corporate investors – including Google, Salesforce, and Cisco – acknowledged an increase in income and expense volatility is expected as a result of this transition. The portion of the investment landscape inhabited by corporate venture players continues to increase. Industry participants have begun adapting to the resulting changes of corporate participation. Both founders and investors will likely keep close watch as industry changes continue to unfurl and as corporate VCs begin to adopt these new requirements.

Over the past decade, we have been retained by several investment funds to assist them in responding to formal and informal SEC investigations regarding fair value measurement of portfolio investments. Reflecting back on those engagements yields a couple observations and reminders for funds and fund managers as they go through the quarterly valuation process.First, fund managers should recognize that valuation matters, and it will really matter when something has gone awry. To that end, we recommend that funds:Document valuation procedures to follow (and follow them). Since valuation requires judgment, disagreements are inevitable. However, are you following the established valuation process? In hindsight, judgments are especially susceptible to second-guessing if established policies and procedures are not followed.Designate a member of senior management to be responsible for oversight of the valuation process. Placing valuation under the purview of a senior member of management demonstrates that valuation is an important function, not a compliance afterthought.Create contemporaneous and consistent documentation of valuation conclusions and rationale. No valuation judgment is “too obvious” to merit being documented. On the other side of the next crisis, what seems reasonable today may appear anything but. The middle of an investigation is not the best time to re-construct rationales for prior valuation judgments.Second, it is important for fund managers to stay abreast of evolving best practices (or know people who do). Fair value measurement for illiquid portfolio investments is an evolving discipline. We recommend that funds:Solicit relevant input from the professionals responsible for the investment, auditors, and third-party valuation experts. Relying on appropriate professionals demonstrates that the fund managers take compliance seriously and are committed to preparing reliable fair value measurements.Check your math. In the glare of the regulatory spotlight, few things will prove more embarrassing than elementary computational errors. The proverbial ounce of prevention is certainly worth the pound of cure.Disclose the valuation process and conclusions. Just like potential investors do, regulators take comfort in transparency.The best time to prepare for a regulatory investigation is before it starts. Call us today to discuss your portfolio valuation process in confidence.Originally published on Mercer Capital's Portfolio Valuation Newsletter: Second Quarter 2017

The following outlines our process when providing periodic fair value marks for venture capital fund investments in pre-public companies.Examine the most recent financing round economicsThe transaction underlying the initiation of an investment position can provide three critical pieces of information from a valuation perspective:Size of the aggregate investment and per share price.Rights and protections accorded to the newest round of securities.Usually, but not always, an indication of the underlying enterprise value from the investor’s perspective. Deal terms commonly reported in the press (example) focus on the size of the aggregate investment and per share price. The term "valuation" is usually a headline-shorthand for implied post-money value that assumes all equity securities in the company’s capital structure have identical rights and protections. While elegant, this approach glosses over the fact that for pre-public companies, securities with differing rights and protections should and do command different prices. The option pricing method (OPM) is an alternative that explicitly models the rights of each equity class and makes generalized assumptions about the future trajectory of the company to deduce values for the various securities. Valuation specialists can also use the probability-weighted expected return method (PWERM) to evaluate potential proceeds from, and the likelihood of, several exit scenarios for a company. Total proceeds from each scenario would then be allocated to the various classes of equity based on their relative rights. The use of PWERM is particularly viable if there is sufficient visibility into the future exit prospects for the company. The economics of the most recent financing round helps calibrate inputs used in both the OPM and PWERM.Under the OPM, a backsolve procedure provides indications of total equity and enterprise value based on the pricing and terms the most recent financing round. The indicated enterprise value and a set of future cash flow projections, taken together, imply a rate of return (discount rate) that may be reasonable for the company. Multiples implied by the indicated enterprise value, juxtaposed with information from publicly traded companies or related transactions, can yield valuation-useful inferences.Under the PWERM, in addition to informing discount rates and providing comparisons with market multiples, the most recent financing round can inform the relative likelihood of the various exit scenarios. When available, indications of enterprise value from the investor’s perspectives can further inform the inputs used in the various valuation methods. In addition to the quantitative inputs enumerated above, discussions and documentation around the recent financing round can provide critical qualitative information, as well.Adjust valuation inputs to measurement dateBetween a funding round and subsequent measurement dates, the performance of the company and changes in market conditions can provide context for any adjustments that may be warranted for the valuation inputs. Deterioration in actual financial projections may warrant revisiting the set of projected cash flows, while improvements in market multiples for similar companies may suggest better pricing may be available for the company at exit. Interest from potential acquirers (or withdrawal of prior interest) and general IPO trends can inform inputs related to the relative likelihood of the various exit scenarios.Measure fair valueMeasuring fair value of the subject security entails using the OPM and PWERM, as appropriate and viable, in conjunction with valuation inputs that are relevant at the measurement date. ASC 820 defines fair value as, "The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date."Reconciliation and tests of reasonablenessA sanity check to scrutinize fair value outputs is an important element of the measurement process. Specifically as it relates to venture capital investments in pre-public companies, such a check would reconcile a fair value indication at the current measurement date with a mark from the prior period in light of both changes in the subject company, and changes in market conditions.Mercer Capital assists a range of alternative investment funds, including venture capital firms, in periodically measuring the fair value of portfolio assets for financial reporting purposes to the satisfaction of the general partners and fund auditors. Call us – we would like to work with you to define appropriate fund valuation policies and procedures, and provide independent opinions of value.